Financial markets

The pound and gilts

Not such a safe haven

AFTER the party, the hangover. The UK had a successful Olympics in 2012 and the Royal Jubilee was the icing on top; national pride was revived. True, the economy did not perform well and it was the wettest year since Noah developed an interest in carpentry. But the UK was still seen as a safe haven, relative to the chaos in the euro zone.

But the mood has changed in 2013 and investors seem inclined to believe the euro will muddle through. Arguably, the mood is too complacent; nevertheless, the pound has fallen steadily against the euro since the start of the year. British exports will not mind that, nor the slight decline against the dollar. The more worrying development is the rise in gilt yields, which have popped above 2%. The low level of gilt yields is often cited by ministers as a sign of market approval of the government's deficit-cutting strategy. But, just as plausibly, it is down to the Bank of England's purchase of a third of all gilt issuance and a flight to safety by European investors fearing a euro-break-up. Both these flows have, for the moment, stopped. Unlike the dollar, the world's reserve currency, and treasury bonds, the most liquid market in the world, no-one has to own sterling or gilts.

Nor, when you look at it, is the deficit-cutting record that stellar. Figures just released show that taxes in calendar year 2012 were £534.3 billion, up from £531 billion in 2011. But spending rose even faster from £611 billion to £630 billion. Even if interest and social benefits are excluded, other spending rose from £383.6 billion to £395.5 billion. Many people think that this will be the year that Britain loses its AAA rating.

And now the prime minister has committed the country to an in-out referendum on EU membership before the end of 2017 (as discussed by my colleagues here). This looks like a scheme that is primarily designed to deal with the right-wingers in Mr Cameron's party and the electoral threat of UKIP, the isolationist party that some fear might top the polls in the EU parliamentary elections next year and deprive the Tories of a majority in the general election of 2015. Alas, it is hardly a plan that creates certainty for businesses planning direct investment into the UK. My colleague asked a room full of chief financial officers yesterday whether they wanted an in-out referendum on Europe, and not a single one raised his hand. It used to be the case that the Conservatives were the party of business; how did this happen?

Readers' comments

' It used to be the case that the Conservatives were the party of business; how did this happen?'
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You said it - UKIP hysteria, fuelled by tabloid faux outrage.
Cameron would be better off abandoning this angry, xenophobic subset of the electorate and focussing on sensible polices aimed at wooing back the floating voters (of which I am one of many).

"It used to be the case that the Conservatives were the party of business; how did this happen?"

I think the changing CV of most politicians has a lot to do with it.Very few have business experience now, except at such a junior level that they'd get little insight from it.

Oh, they say they're all for the single market. But they don't actually know what it is, really. Lord Cockfield, who designed the single market, was Finance Director, then Managing Director of Boots in the 60's. Then advisor to MacLeod and Barber, then Chairman of the Price Commission in the 1970's.

And all that, before going off to Brussels as Internal Market Commissioner in the 80's.

Are there any Conservative Politicians left, with that kind of CV? I suspect not.

There's a good comparison between the government debt of all EU countries just out, though it only goes up to Q3 2012:http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-23012013-AP/EN/2-230...
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It's a mixed bag, but the UK's debt position doesn't look any prettier than France, Italy or Spain.
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The rate of debt issuance in Europe is falling fast - austerity is working, even if it has meant deep recession. Good - sustainable growth is only possible without fiscal incontinence.
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Sterling probably will depreciate further (which is good for attracting FDI & job creation).
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The more relevant question is indeed the risk of capital flight or growing yield spreads (e.g. if fears worsen that the BoE would tolerate excessive inflation/ depreciation, or if fears worsen that the UK government is more likely to compromise Sterling than to repay debts in real terms). If such perceptions were to spread, then the UK would be stuck with the moral hazard which suffocated Italy in the 1990s (i.e. intractably higher real interest rates than comparable economies).
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Thankfully (thank this government!), there is no evidence of this yet. It is true that if the BoE slows bond buying (it might or might not), foreign creditors will have to step in - which will mean currency depreciation and higher yields than in France (or within 2 years perhaps even Italy, which benefits from excess domestic savings, a current account surplus and very small fiscal deficit). Yet, providing confidence remains in the 2% inflation target and in the determination of UK government to honestly pay its debts, real yields in the UK will continue to be favourable for investment and growth.
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Taking the above as given, that leaves the British government with other priorities:
- get back to liberalising construction planning (we need to be allowed to build houses, offices & manufacturing plant, at short notice to meet market demand).
- put full pressure on the US to engage with a comprehensive EU-US FTA (Ireland, Germany & Netherlands are doing all the grunt work - we should add our full & active support)
- eliminate VAT deductions and the distortions they cause - allow the middle classes to eat in restaurants (creating jobs) rather than subsidise their cold food; allow the correct market incentives for household investment in insulation & efficiency (instead of rich people claiming subsidies on their disproportionately large quantities of under-rated gas & electric)
- liberalise childcare - let mothers (and fathers) work; eliminate oppressive & unreasonable ratio caps
- work closely with other European governments to deepen the single market, promoting seamless cross border expansion of good businesses; work to accelerate European neighbourhood policy, and accession of new states
- cut corporation tax faster, and allow businesses (especially small businesses) to compete based on productivity rather than on the quality of their accountants; allow productivity-boosting capital investments to actually happen (eliminate the tax advantage for consumer credit over business credit)
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And a few other such matters to raise productivity and incomes in the UK...

Sensing some rather blatant bias in this article, not expected in a paper dedicated to the pursuit of intelligence. For instance -
'My colleague asked a room full of chief financial officers yesterday whether they wanted an in-out referendum on Europe, and not a single one raised his hand'
Not exactly a scientific test, is it? More a confirmation of inertia combined with group-think. Confirmation bias.
'electoral threat of UKIP, the isolationist party'
Isolationist from what? UKIP has nothing against free trade - more about protecting a nations standard of living. If all the worlds resources were divided equally we would all be in poverty. That euro-centric bias rears its ugly head again, remember we're not all converted yet...

"the wettest year since Noah developed an interest in carpentry"
ooh, Buttonwood, you're so sharp you'll cut yourself!
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"It used to be the case that the Conservatives were the party of business; how did this happen?"
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My guess is when Maggie became the leader and that ideologue Keith Joseph started dribbling nonsense in her ear. Their policies led to big bang deregulation of finance and the subsequent worship of financial institutions by politicians of all parties.

"It used to be the case that the Conservatives were the party of business; how did this happen?"
It used to be that The Economist favoured democracy. I hope it still does. Bite your tongue, The Economist, save your rants, and argue instead for why that vote should be a "Yes" vote as David Cameron and I (inter alia) believe.
Besides, your correspondent has not done a proper survey. People do not like raising their hands. It's a well-known phenomenon.
"John Cridland, director-general of employers' group, the CBI, said "closer union of the eurozone is not for us" but Mr Cameron "rightly recognises the benefits of retaining membership of what must be a reformed EU". John Longworth, director general of the British Chambers of Commerce, said the announcement showed Europe had to take the PM seriously, but added: "The lengthy timescale for negotiation and referendum must be shortened, with the aim of securing a cross-party consensus and the outline of a deal during this Parliament."" ~ BBC.

Ten-year Gilts could yield almost as much as German Bunds at one point. We can doubt that the EMU crisis could be solved just by the ECB's big bazookas, but the upward drift in Gilt yields looks pretty rational in a changed climate, and 2% is half as much as when Greece was bailed out for the first time so it should be barely a matter of concern.
Another reason not to blame this supposed loss of safe-haven status on the coalition's latest policy mishaps is that US Treasuries have followed a very similar path and I'm not sure that the political ructions over budget matters were the culprit. In a global search for yields inspired by QE and the likes, there is little place for them in a bond portfolio. Benchmark 10-year yields haven't (yet) overshot 2% but have mostly traded below UK equivalent for being the most liquid bond market in the world.

Word on the markets is that the increase in gilt yields was caused by the good unemployment figures, and other tentatively good economic signs - making it (marginally) more likely that the MPC would raise base rates.

I wondering if the Eu thing is a lot about conservative party and trying to sell the the Eu thing to the public rather than a real pressing issue the public have to appease the party. The benefits 1 percent a cheap poltic points over creating diverseve issues.
The anti imginagtion also appear to some a bit of popularist cheap shot to extent and possibly diversive. The problem uk has is not imigeration in my view, not the Eu nor that benefits are paid consuer price index.
How is this leaving Eu thing going to help stablity, may be it would be worth downgrading credit rating on that if already on shakey ground. if was creditable and current possibly but as can kicked in to future i supose not current issue.
The covervative party seems to be becoming the daily mail readers partly. The issues that posteruing on do seem like fringe issues. I supose with what 2 years till election and economy not picking up, the credit rating at risk. This switch to fringe issues.
Not sure buiness is anti EU anti imigrations or even anti benefit as good multipliers and there is enough slack in labour market EU people can help to fill roles. The minium wage would guess has more to do with hiring for unskilled roles than incentives of benefits. As could problery hire below it.
personally think this fringes issues are childish poltics thats get in all parties from time to time.